Austerity in the European Periphery : the Irish Experience

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UCD GEARY INSTITUTE FOR PUBLIC POLICY

DISCUSSION PAPER SERIES

Austerity in the European periphery: the Irish

experience

Niamh Hardiman

School of Politics and International Relations and Geary Institute for Public Policy,

University College Dublin

Spyros Blavoukos

Athens University of Economics and Business, Athens

Sebastian Dellepiane-Avellaneda School of Government and Public Policy

University of Strathclyde, Glasgow

George Pagoulatos

Athens University of Economics and Business, Athens,

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Austerity in the European periphery: the

Irish experience

1

Niamh Hardiman2

School of Politics and International Relations and UCD Geary Institute for Public Policy, University College Dublin

Spyros Blavoukos

Athens University of Economics and Business, Athens, Greece

Sebastian Dellepiane Avellaneda

School of Public Policy and Government, Strathclyde University, Glasgow, UK

George Pagoulatos

Athens University of Economics and Business, Athens, Greece

Abstract: Ireland has come to be seen as an exemplary case of the successful practice of austerity, both economically and politically. But these inferences would be misleading. The real story about fiscal adjustments in Ireland is more problematic, the reasons for recovery are more complex, and the political consequences are a good deal more nuanced. This paper sets the Irish experience alongside that of the other Eurozone periphery countries. It argues that these countries’ recovery prospects depend on the EU economic policy framework, but that Ireland’s connections to non-Eurozone economies also shape its growth prospects. Political stability is problematic in all the periphery countries, with the rise of challenger parties articulating values and priorities that may be difficult to accommodate within the current European policy regime. This is connected to a wider problem of the decay of older political identities and loyalties and the emergence of a new legitimation gap for EU member states.

Keywords: Austerity, fiscal adjustment, Ireland, Eurozone, periphery, recovery, EU economic policy, political stability.

JEL: F15, F21, F550, F68, N140, O52, O57, P16.

1 This Working Paper will feature as a chapter in the forthcoming Debating Austerity in Ireland,

eds. Emma Heffernan, John McHale, Niamh Moore-Cherry. Dublin, Royal Irish Academy, 2016.

2 Corresponding author: Dr Niamh Hardiman,SPIRe and UCD Geary Institute for Public Policy,

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Introduction

Ireland has come to be seen as an exemplary case of the successful practice of austerity. Its success in exiting its 2010 loan programme, and doing so early, was lauded by the European Commission. Year-on-year GDP growth in 2015 was at the top of the EU league with a remarkable reported rate of 6%; job creation was buoyant; unemployment was below the Eurozone average of 10.5%. Ireland’s experience was in marked contrast with that of the southern European countries with which it had recently been closely linked (Brazys and Hardiman 2015 ). These outcomes have been attributed to thoroughgoing implementation of the austerity measures required by Ireland’s 2010 loan programme, supported by strong continuity in two successive governments’ policy stance. In addition, Ireland’s experience is taken to indicate that sustained pursuit of fiscal retrenchment need not be politically destabilizing or even particularly costly politically. But these inferences would be somewhat misleading. The real story about fiscal adjustments in Ireland is more problematic, the reasons for recovery are more complex, and the political consequences are a good deal more nuanced.

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Austerity in the European periphery

The experience of crisis in the European periphery, including Ireland, cannot be understood independently of the broader political and economic governance of the Eurozone.

Uneven European institutional capacity to respond to the crisis

The institutional framework governing Economic and Monetary Union (EMU) constrained the repertoire of policy responses available to national governments and intensified the experience of austerity (Wolff and Sapir 2015). Simon Wren-Lewis, noting that we should draw a distinction between ‘ordinary’ fiscal consolidation, and fiscal adjustments that are tantamount to ‘austerity’ policies, defines austerity as:

fiscal consolidation that leads to a significant increase in involuntary unemployment, or perhaps more formally but less colloquially as leading to a noticeably more negative output gap

(Wren-Lewis 2015)

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plummeting revenues pushed Ireland and Spain into serious fiscal difficulties, intensified the public spending problems of the Greek state, and stalled the already anaemic economic activity in the Portuguese economy. The fiscal crisis of the Eurozone was a consequence of the collapse of the banking system, and not itself a primary cause of crisis (Baldwin and Giavazzi 2015).

Early responses to the crisis in 2008/9 had involved a coordinated G20-wide fiscal expansion that prevented a slump into depression analogous to the Great Depression. However, the exposure of the true scale of Greece’s fiscal problems in 2009 and the eruption of its sovereign debt crisis in May 2010 brought about a rapid change of course from the European authorities. The ‘unfinished architecture’ of the Eurozone (Schmidt 2010) resulted in slow and protracted series of attempts to generate sufficient consent, institutional capacity, and financial reserves to deal appropriately with the situation. The European authorities struggled to respond adequately to the banking sector crisis and its fallout for governments’ borrowing capabilities. After Greece, Ireland and then Portugal ceased to be able to borrow on international markets, and the permanent European Financial Stability Mechanism was only put in place in October 2012. An EU framework for resolution of failing banks was not agreed until 2014.

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Coordination and Governance in the Economic and Monetary Union) entered into force in January 2013. But by that time, the existential crisis of the Euro had abated – not because of the prospect of stricter fiscal rules, but because of the ECB’s market-calming assurances in July 2012 that it would ‘do whatever it takes’ to protect the Eurozone from collapse (De Grauwe and Ji 2013), followed in due course by a programme of monetary expansion or Quantitative Easing (QE).

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Asymmetrical macroeconomic policy mix

The countries that were subject to loan programmes – Greece, Ireland and Portugal, and Spain in respect of its banking sector – were subject to tight monitoring of their compliance with austerity measures. To varying degrees, they were also subject to additional ‘structural adjustment’ requirements, intended to facilitate new growth, in the expectation that supply-side liberalisation and deregulation was all that stood between these countries and renewed growth. These measures were subject to varying levels of implementation because they often proved most destabilizing to those groups, especially in the public sector, who were already adversely affected by austerity. But in any event, there was little evidence to support the expectation of significant growth from reforms such as these in the short or even medium term. And yet there were no other mechanisms in place to generate growth: public investments were constrained by the fiscal constraints these countries were required to observe, and private investments were limited due to the incapacity and unwillingness of banks to engage in new lending.

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Figure 1: Competitiveness index

Source: European Central Bank

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The very sudden collapse of domestic living standards in the periphery after 2008 was also an unnecessarily painful experience, seen in a wider European context. In an integrated economy, dearth of demand in one region can be offset by its increase in another, facilitated by their common currency. But Figure 2 shows the highly asymmetrical adjustment required of the Eurozone periphery in the absence of increased economic activity in the core.

Figure 2: Asymmetrical macroeconomic adjustment in trade relations

Source: EU Eurostat

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European periphery to break out of its traditional niches of low-end production and a concentration of activity in non-tradable sectors of the economy. The consumption boom and the unproductive housing boom in the periphery during the 2000s, associated with unrestrained lending from the core, had further reinforced these perverse asymmetries.

IMF research showed that the effects of fiscal retrenchment within the Eurozone member states after 2009 had cumulative effects that spread across borders, and that the multiplier effect of austerity was a good deal higher than anticipated in some of the worst-affected cases (IMF 2012). And yet the European Commission’s own new Macroeconomic Scoreboard, intended to track dimensions of potentially destabilizing economic performance that had hitherto attracted little attention, explicitly permitted a bigger maximum current account surplus (+6%, which Germany consistently exceeded since 2012 anyway) relative to the largest permissible deficit (a threshold of -4%).

Variations in adjustment

The experience of austerity in the European periphery cannot be understood without understanding its relationship to what was happening in the core. At the same time, there was a good deal of variation in the experiences of austerity across the periphery countries themselves. The economic impact of the measures taken depended on a number of factors including the fiscal starting conditions of each country, the configuration of its welfare provisions, the administrative and implementation capacity of the system, and the recovery capacity of the economy.

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Figure 3: Scale of fiscal retrenchment, 2009 - 2012

Source: OECD Economic Outlook, Volume 2012, Issue 2, 17 December 2012.

The preferred adjustment strategy supported by the official lenders favours spending cuts over tax increases; the revenues of the affected countries had in any case plummeted in the context of recession. Cuts in public spending may be considered more tolerable through the lens of prioritizing deficit reduction and limiting damage to output potential. But there are disproportionate distributional effects on those who depend on public transfers and public services. The social consequences of the austerity measures, implemented in the depths of economic crisis and without direct growth-promoting mechanisms, were severe.

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Figure 4: Total unemployment rate

Source: EU Eurostat

In Ireland and Spain, some of the increase is attributable to the shock caused by the initial collapse of the construction sector. But prolonged recessionary conditions, the freeze in bank lending despite extensive recapitalisation, and the burden of private debt on households and on non-financial firms alike, resulted in a sustained period of stagnation across most of the periphery. Youth unemployment typically ran at about twice the average rate in the overall economy; in Spain and in Greece, there is little exaggeration in speaking of a ‘lost generation’ of youth with restricted employment prospects, limited access to welfare supports, and few prospects of independent living.

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attributable to higher taxes and charges and cuts in public services and income transfers. These reductions were net of income losses from other sources such as unemployment, lower wages, and lower incomes from self-employment. The income drop was very similar across most of the income range at about 11%. But it was higher among the band of households with the lowest incomes. It was highest, at over 15%, in the top income group (Keane et al. 2015), in part because of the structure and incidence of taxation in Ireland. Among the lowest income groups, the increase in direct taxes and the introduction of new charges, combined with cuts in services, resulted in an increase in the incidence of deprivation, a measure of income adequacy to meet basic social needs undertaken by the Study of Income and Living Conditions (SILC) and reported by the Central Statistics Office. The categories particularly at risk were the unemployed and parent households. Deprivation rates rose from about one-quarter to half for the lowest income decile, and from almost two-fifths to three-fifths between 2008 and 2013 for the second-lowest income decile (Farrell 2015). On an aggregate index of ‘social justice’ including access to health care, education, the labour market, poverty prevention, and social cohesion, Ireland was among the lowest 10 of the EU28 (Schraad-Tischler 2015).

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the German model of export-driven growth through wage and other cost repression.

But the inference that austerity caused recovery is not well grounded in the Irish case – if anything, it could be argued that recovery came about in spite of austerity. It is true, as Figure 1 shows, that Irish competitiveness based on unit labour costs showed some relative improvement during the recession. But the conditions behind this are more complex than the story of a beneficial ‘internal deflation’ might suggest. Firstly, the relative improvement in competitiveness began in 2007, before the implementation of any austerity measures, with the stalling of the housing boom and the end of the long spell of diverting investments into unproductive assets. Aggregate productivity data improved because of rising unemployment in the relatively low-skilled, low-value-added construction sector.

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Thirdly, it is true that Ireland’s real effective exchange rate improved in parallel with the implementation of austerity measures, as Figure 5 shows.

Figure 5: Real effective exchange rates

Source: Bruegel Dataset

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Political effects of austerity

The economic crisis exposed new tensions between the need for unified European-level policy responses, where national economic needs were very diverse. What then were the implications for domestic politics? In the early stages of the crisis, it seemed that national governments would manage the crisis within the existing framework of debate and without major disruption to established party systems. Lindvall, for example, anticipated that the politics of conservatism would assert itself at first, as voters sought to restore stability, and that this would be followed by a resurgence of Social Democracy to tame the markets and reassert distributive priorities (Lindvall 2014). Sure enough, the initial elections held during the crisis resulted in changes of government in which the established opposition party or parties benefited. Those held responsible for implementing unwelcome austerity were punished electorally, whether in a shift from left to right (as in Spain and Portugal) or from centre-right to centre-left (as in Ireland). There seemed to be ‘no general ideological shift in response to the Great Recession’ (Bartels and Bermeo 2014, p.12).

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right coalition of Social Democrats and Christian Democrats lost its majority in 2015 to a leftward surge in support not just for the mainstream opposition Socialists, but in particular for the smaller, far-left parties that had been excluded from government formation until now. As in Spain, no stable majority government could be formed, and the Socialists had to resort to building ad hoc coalitions to support policy, one issue at a time. The most dramatic collapse of the party system took place in Greece. The challenger party SYRIZA came from the radical left; it benefited from the all-but-complete collapse in 2012 of the mainstream social democratic PASOK and the discrediting of its main rival New Democracy – and from the frustrations of Greek voters with the hardships imposed in turn by PASOK and New Democracy and mandated by the terms of Greece’s loan agreements.

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But the Irish electoral system permitted something rather different too, that is, the emergence of a sizeable number of representatives elected on their individual credentials, either representing small leftist parties or organizing into looser alliances of blocs, and accounting for about 25% of voters’ first preferences. The prospects of forming a stable government in the wake of the parliamentary general election scheduled for spring 2016 were likely to depend on the decisions of at least some of these representatives. These fragmented challenger parties and candidates in Ireland mobilised much of their support through campaigns of opposition to the new taxes and charges introduced during the years of austerity. Ireland’s poorly-developed revenue system had long failed to tax important assets such as housing, and payment for services and utilities such as waste collection and domestic water usage had not been clearly linked to levels of consumption. Under the terms of the loan agreement, Ireland was required to broaden its tax base and to raise new revenues from these and other sources. A Universal Social Charge (USC) was also mandated, to rationalise a complex set of rates and bands governing different types of social insurance and other levies. The defenders of the USC noted that it improved the visibility of higher earners to the revenue authorities because it was hard to avoid. But its regressive incidence was widely resented.

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To forestall continued clashes, they were willing to enter into negotiations with both of the governments that had held power; the ensuing agreements converted ‘voice’ into a grudging acquiescence, if not actual ‘loyalty’. The later waves of protest, organised by radical left organisations, mostly appealed to those sections of the electorate that did not feel represented by the trade unions – whether because they were unemployed, or because they perceived the unions’ actions and the Labour Party’s concerns to be more beneficial to public sector than to private sector employees.

The political effects of austerity on Irish politics were therefore in many ways quite similar to those seen in the other periphery countries. But there was one striking point of difference. Unlike the rest of the Eurozone, the Irish economy in 2014 and 2015 showed signs of renewed growth. The governing parties hoped that more jobs, more disposable income boosted by tax concessions, and some increased spending, would bring more voters round to supporting them in time for the 2016 elections. Protest vote intentions were strongest during the worst of the recession; an improvement in economic performance took some of the heat from the politics of opposition (Louwerse 2015).

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dissatisfaction into protest, protest into votes, and votes into seats, let alone seats into bargaining capacity in government formation, was as yet untested.

Conclusion

We have noted that Ireland’s experiences of austerity cannot be fully understood without recognizing that Ireland, along with the other periphery states in the Eurozone, is embedded in a broader European economy, and that the economic fortunes of the periphery are not independent of what happens elsewhere. Ireland’s budgetary policy continued to be shaped by newly tightened European fiscal rules, but Ireland began to escape the pervasive stagnation of the southern periphery because its productive activities were more closely integrated into the Anglo-European economy. Nonetheless, its recovery depended on the congruence of favourable conditions whose continuation were beyond the control of national government, such as the appreciation of the dollar and sterling relative to the Euro, low interest rates on still very high sovereign debt and private debt, low oil prices, and stability in the wider international economy, including China.

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The economic crisis may therefore have exposed something more fundamental about European politics, which is that political representation and accountability to voters is increasingly at odds with governments’ responsibilities toward actors outside the national territory: this is Peter Mair’s analysis (Mair 2014, 2013). Governments incur obligations to comply with EU treaties and rules, but the legitimacy of the EU itself depends heavily on good economic performance. If the EU can offer no hope of a better future, Euroscepticism and even far-right nationalism can flourish at the domestic level (Scharpf 2014). Governments are also obliged to anticipate the responses of international financial markets to their policy choices. Together, these constraints mean that no single government has the capacity to adopt a heterodox policy stance (Dellepiane and Hardiman 2012; Dellepiane-Avellaneda and Hardiman 2015). Greece’s attempts to alter the macroeconomic priorities of the EU in mid-2015 failed, and the terms of its new loan agreement were more severe than those which had facilitated the rise to power of SYRIZA in the first place.

Across Europe, the individualisation of voting behaviour as older loyalties eroded, combined with an apparent lack of responsiveness of national parties to voter anxieties about unemployment, stagnating incomes, and debt, contributed to a growing sense that there was little to choose between parties. All of this fed into a wider disenchantment with and cynicism about politics itself. Political organisations that offered a politics of greater responsiveness to popular concerns, whether from the left or the right, began to do well in the polls. The left challenger parties in the periphery were not hostile to the EU or to EMU. But the rise of the extreme right from France to Greece, and the accession to power of the nationalist right in Hungary and Poland, articulated an alternative view of national interests that would put them increasingly at odds with the EU itself. To some, the European democratic project itself was entrapped by the technocratic logic of the market (Offe 2014). It remained to be seen whether European countries, and the EU itself, could ‘get the politics right by enabling citizens greater say over decision-making in ways that serve to rebuild trust while counteracting the rise of the extremes’ (Schmidt 2015, p.112).

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Figure

Figure 1: Competitiveness index

Figure 1:

Competitiveness index p.8
Figure 2: Asymmetrical macroeconomic adjustment in trade relations

Figure 2:

Asymmetrical macroeconomic adjustment in trade relations p.9
Figure 3: Scale of fiscal retrenchment, 2009 - 2012

Figure 3:

Scale of fiscal retrenchment, 2009 - 2012 p.11
Figure 4: Total unemployment rate

Figure 4:

Total unemployment rate p.12
Figure 5: Real effective exchange rates

Figure 5:

Real effective exchange rates p.15

References

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